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Asset Return Predictability in a Heterogeneous Agent Equilibrium Model

Author

Listed:
  • Murray Carlson

    () (Finance Division, Sauder School, University of British Columbia, 2053 Main Mall, Vancouver, BC, Canada V6T 1Z2, Canada)

  • David A. Chapman

    () (McIntire School of Commerce, University of Virginia, Charlottesville, VA 22904-4173, USA)

  • Ron Kaniel

    () (Simon School of Business, University of Rochester and IDC Herzliya, and CEPR, Rochester, NY 14627, USA)

  • Hong Yan

    () (Shanghai Advanced Institute of Finance, Shanghai Jiao Tong University, 211 West Huaihai Rd., Shanghai, China 200030, China)

Abstract

We use a general equilibrium model as a laboratory for generating predictable excess returns and for assessing the properties of the estimated consumption/portfolio rules, under both the empirical and the true dynamics of excess returns. The advantage of this approach, relative to the existing literature, is that the equilibrium model delineates the precise nature of the risk/return trade-off within an optimizing setting that endogenizes return predictability. In the experiments that we consider, the estimation issues are so severe that simple unconditional consumption and portfolio rules actually outperform (in a utility cost sense) both simple and bias-corrected empirical estimates of conditionally optimal policies.

Suggested Citation

  • Murray Carlson & David A. Chapman & Ron Kaniel & Hong Yan, 2015. "Asset Return Predictability in a Heterogeneous Agent Equilibrium Model," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 5(02), pages 1-45.
  • Handle: RePEc:wsi:qjfxxx:v:05:y:2015:i:02:n:s201013921550010x
    DOI: 10.1142/S201013921550010X
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    References listed on IDEAS

    as
    1. Yihong Xia, 2001. "Learning about Predictability: The Effects of Parameter Uncertainty on Dynamic Asset Allocation," Journal of Finance, American Finance Association, vol. 56(1), pages 205-246, February.
    2. John Y. Campbell & Luis M. Viceira, 1999. "Consumption and Portfolio Decisions when Expected Returns are Time Varying," The Quarterly Journal of Economics, Oxford University Press, vol. 114(2), pages 433-495.
    3. Hindy, Ayman & Huang, Chi-fu & Zhu, Steven H., 1997. "Optimal consumption and portfolio rules with durability and habit formation," Journal of Economic Dynamics and Control, Elsevier, vol. 21(2-3), pages 525-550.
    4. Detemple, Jerome B & Zapatero, Fernando, 1991. "Asset Prices in an Exchange Economy with Habit Formation," Econometrica, Econometric Society, vol. 59(6), pages 1633-1657, November.
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    Cited by:

    1. Weidong Tian & Murray Carlson & David A. Chapman & Ron Kaniel & Hong Yan, 2017. "Specification Error, Estimation Risk, and Conditional Portfolio Rules," International Review of Finance, International Review of Finance Ltd., vol. 17(2), pages 263-288, June.

    More about this item

    Keywords

    Return predictability; general equilibrium model; empirical experiments; optimal portfolio rules; relative utility cost;

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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